How to Tackle Mortgage Fraud

For all the negative impacts associated with industry fraud, the courts have finally shown a willingness to punish players who made it happen. In August 2006, a former American Home Mortgage Investment Corp. branch manager in Alaska was sentenced to two years in prison, fined $50,000, and ordered to pay $140,000 in restitution for wire fraud. He pleaded guilty to falsifying documents to secure stated income loans for customers while working for American Home Mortgage Investment Corp. and Countrywide Financial. This is the first known case in which an originator received jail time for increasing a borrower’s income on the application, a common industry practice. Its an important first step to creating a deterrent.

While advancements in technology have improved the industry’s effort at detecting fraud, there is still a long way to go. By most estimates, lenders lose tens of millions of dollars each year as a result of fraudulent activities. Even though I, as a lender, encountered fraud on a daily basis, there was little my organization could do to help other companies. Without a mechanism to share the information with other lenders, fraudulent brokers could easily move from one mortgage banker to another. The solution is to develop a national scoring system that tracks fraudulent activities for all loan originators.

The same way borrowers are scored based on their total credit profile, loan originators would earn fraud scores based on how they performed relative to certain measurements. If lenders took the raw data from each loan (without the borrower name and Social Security number) and submitted it to a central repository, a group of skilled statisticians could use the information to develop a scoring model.

In order for it to work, the system would require a gatekeeper. Whether the score was developed by a private company or through an industry-wide effort (coordinated by the Mortgage Bankers Association, for example), the system would be dependent on lenders providing the gatekeeper with data to develop a scoring model. Any lender that wanted access to the scores would pay a subscription for the service. Ideally lenders that contributed data to the service would pay less for the subscription than lenders that didn’t.

The key to making it work is to insure the methodology is understandable to lenders and brokers. The reason goes back to motivation and behavior. If a loan officer realizes a fraud score worsens if a large percentage of deals are closed as stated income loans, it motivates them to not take the easy way out. Conversely, if a loan originator knows certain behaviors will improve their score, they’re more inclined to act in that manner. Could you imagine the impact a loan officer’s score would have if it was tied to risk-based pricing? How long do you think a broker with a low score could survive if his borrowers were subjected to a 50 basis point price hit because of his low ranking?

Once enough information was compiled to create a reliable database, lenders would develop their own policies on how to use the scores. A loan officer who consistently received a poor fraud score would quickly find himself looking for a new career. A scoring system that potentially threatens an originator’s livelihood becomes an enormous deterrent to fraudulent activity. If the use of fraud scores gained widespread acceptance among lenders, the agencies could eventually use them in rating securities.

Would such a system eliminate mortgage fraud? No way. But fraud has to be tackled through a collective system-wide effort if there is any hope of curbing it. Unless data can be shared and penalties employed for erratic or poor behavior, the problem will never be adequately addressed. While I have focused the issue primarily on brokers, there is no reason this couldn’t apply to other players as well, including lenders, appraisers and other third party vendors.

Admittedly, this does nothing to punish consumers who attempt to commit fraud, but under this system it becomes somewhat of a non-issue. It’s amazing how quickly industry players will understand the meaning of due diligence when their livelihood rides in the balance.